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News - 5 July 2007

Interest rates continue upwards

As expected the Bank of England raised UK interest rates from 5.5% to 5.75% earlier today. This is the fifth rate rise in 11 months. Is there more to come?

Blaming the dangers of inflation the Monetary Policy Committee (MPC) warned "most indicators of pricing pressure remain elevated" which many analysts are interpreting that there may be a further rise to 6% later in the year.

The higher rates will add between £15 and £20 a month to an average £100,000 repayment mortgage which will leave many borrowers facing difficulties.

The British Chambers of Commerce urged the Bank of England to take its time over any further rate rises. Their economic adviser David Kern said; -

"It should allow more time for previous interest rate increases to have their effect before rushing to raise interest rates further, thus inflicting lasting damage on the economy,"

Business groups say that the Consumer Prices Index (CPI), slowed to 2.5% in May from 2.8% in April, was likely to return to the 2% target by the end of the year even without this increase.

Firms are worried that rising interest rates will continue to increase the strength of the pound, currently trading near a 26-year high, against the US dollar, thus making life more difficult for exporters.

According to some observers, including the Royal Institution of Chartered Surveyors (RICS), the rate rise will depress the housing market and RICS senior economist David Stubbs said: -

"This latest increase in UK interest rates will further dampen housing demand going forward as first time buyers find their borrowing constrained"


Will there be another rate rise before the end of the year?

On the one hand the bank might not increase rates further because inflation is heading downwards as predicted and there might be a risk of over-egging the pudding with more rate increases.

Household finances are being sorely tested and disposable income and savings rates are both at their lowest level for a long time (see earlier stories in knowledgebase). If rates go too high consumers might simply batten down the hatches too quickly thus tipping the economy into a sharp slowdown.

On the other hand the economy is growing at a rate above the long-term trend and consumers do not appear to be flagging despite less disposable income and investment is very strong.

The Bank of England will be keeping a close eye on pay pressures to see if future problems are building up in the economy. The average earnings index grew by 4% in the first quarter of the year which is below the long term trend of 4.5% to 4.75% but big business bonuses are not included in the index.

The general consensus is that the Bank will wait until after the summer to see how the medicine delivered so far has worked but it seems highly likely that, come the autumn, the interest rate will go up by a further quarter point.

Read related items on:
Interest Rate
Bank of England
British Chamber of Commerce
Royal Institute of Chartered Surveyors

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